Top Wall Street banks are to face tough limits on their size and will be ordered to dismantle lucrative chunks of their business after Obama responded to a series of political setbacks by turning his fire on a "binge of irresponsibility" by financiers.

Just a day after his administration suffered a disastrous defeat in a key Senate byelection, Obama shocked the financial industry by announcing that he intended to prohibit some of banks' most lucrative, yet speculative, activities.

Britain's City minister, Lord Myners, will talk to US officials on Monday as part of a meeting with G7 countries to discuss ways to impose a financial levy on a banking system that has already bounced back to profit barely a year after a multibillion pound taxpayer bailout.

In a sign that the White House is responding to public disaffection by getting tougher on those blamed for economic hardship, Obama intends to ban banks from operating hedge funds or private equity funds and will stop so-called "proprietary" trading, whereby they use their own corporate funds to gamble on the financial markets.

"Never again will American taxpayers be held hostage by a bank that is too big to fail," said Obama, who framed his plans in aggressive terms and accused banks of deploying an "army of lobbyists" to block reforms. "If these folks want a fight, it's a fight I'm ready to have."

In the UK, a Treasury spokesman said: "We will consider the proposals very carefully. Countries around the world are rightly taking measures to increase stability and reduce risk in the financial system." The meeting with Myners and G7 officials had already been arranged, but is now expected to focus on the US moves, although there is no certainty that the UK will be able to follow immediately.

A year into his presidency, Obama is facing falling poll ratings and has seen the centrepiece of his policy agenda – reforms to the US healthcare system – thrown into jeopardy by the loss of a once-safe senate seat in Massachusetts that cost Democrats the 60-40 majority they needed to override Republican opposition in the Senate.

White House aides blame discontent among American voters on ongoing economic weakness, as the public grapples with rising unemployment, falling property prices and austerity on the high street. Against this backdrop, Wall Street banks have become deeply unpopular for reaping record profits and handing out huge bonuses - Goldman Sachs today revealed it had made $13bn (£8bn) in profits and that its staff would enjoy average pay packets of $498,000.

Flanked by his economic advisers, Obama said his resolve was strengthened by the spectre of "soaring profits and obscene bonuses" at banks that are still holding back on lending to struggling small businesses.

"The American people will not be served by a financial system that comprises just a few massive firms," he said. "That's not good for consumers, it's not good for the economy."

Present regulations limit any institution from holding more than 10% of America's high street bank deposits, which are insured by the government. Administration officials indicated that this cap was to be broadened to put an overall limit on bank assets, although there was no immediate detail on what size would be considered too big.

The changes, which are considered to be the most stringent restrictions on banks since the Glass-Steagall act of 1933 that followed the Depression and split commercial institutions from investment banks, sent shares in financial companies plunging and pushed the Dow Jones Industrial Average down 213 points.

Republican critics accused the president of using Wall Street as a scapegoat to win back votes. Scott Garrett, a congressman from New Jersey, said: "This renewed focus on financial services reform by the Obama administration is clearly a transparent attempt at faux-populism."

On Wall Street banks protested that simply attacking size was simplistic. David Viniar, chief financial officer of Goldman Sachs, said scale could both help and hinder risk management: "Trying to regulate anything by pure size is a very dangerous thing to do."

The Financial Services Roundtable, which represents US banks, argued that the plans would "restrict lending, increase risk, decrease stability in the system, and limit our ability to help create jobs".

The US proposals, which will require backing from Congress, are likely to spark calls for a renewed clampdown on City risk-taking in Britain. The Liberal Democrat Treasury spokesman, Vince Cable, has been among those urging a return to "narrow banking" with high-street institutions restricted over any speculative investment activities. The chancellor, Alistair Darling, has shown a willingness to face down ­bankers by introducing Britain's one-off 50% tax on City bonuses.